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PG PROFILE: Kroger

Is Kroger scared of Wal-Mart? No way. The nation's largest non-Arkansas-based food chain is No. 1 or No. 2 in 41 major markets.

November 14, 2002, 07:00 pm

Is Kroger scared of Wal-Mart? No way. For starters, the quiet supermarket giant is No. 1 or No. 2 in 41 of the 48 major markets, according to Lehman Brothers, and holding steady against 513 Wal-Marts. "Kroger has weathered the Wal-Mart supercenter storm," says Burt Flickinger III, president of Strategic Resource Group, a New York City-based retail consultancy. "There isn't anything not working. Kroger has a very bright future."

Once the dust from consolidation clears, three major supermarket chains will be left standing, say analysts, and Kroger—besides Ahold and Safeway —is one. No small feat for a chameleon operating under many formats and styles. "It's a slippery company to get your hands around," says Merrill Lynch analyst Mark Husson. "It's multi-divisional, and each one does its own thing." Some 2,447 supermarkets and multi-department stores in 32 states fly under nearly two dozen banners, from warehouse-style Foods Co. to the multi-department Fry's Marketplace. Then there are 782 convenience stores and 439 jewelry stores.

So how does Kroger fend off Wal-Mart? By doing lots of little things well. Stores are well-located, clean, and bright since the company began weeding out weak ones, city by city, in the 1960s and upgrading them to consumers' expectations, says Jean Kinsey, co-director of the Food Industry Center at the University of Minnesota. Also, Kroger has a strong private label, manufactures many of its own grocery items, and sports a successful cache of organics. It has a strong loyalty card, too. "The Kroger shopper card is one of the better loyalty programs in the U.S.," says Flickinger.

The company's not standing still, either. This year it's paring operating costs by $500 million, centralizing buying, and expanding its private labels. "Kroger does 100 things 100 percent better," says Gary Giblen, director of research at C.L. King Associates in New York. "It's a no-nonsense company and very consistent."

Seasoned management helps. Chief executive Joseph Pichler worked his way up through the executive ranks at Dillons. And some other top managers were pulled from former competitors like Smith's. "All division presidents have more operating tenure than those at Albertsons, Safeway, and A&P," says Flickinger.

Marching through Atlanta

Another strength: gobbling up good acquisitions. In the late 1980s, Kroger was saddled with $6.5 billion in debt amassed to fend off a hostile takeover bid. After paying off a good chunk of it by the mid-1990s, Kroger was ready to roll. It quickly snapped up stores with leadership positions, like Fred Meyer's upscale supercenters in 1999. Last year, it wolfed down 34 stores from Baker's, Furr's, and other grocers.

"Kroger is really good at acquiring small groups of stores," says Meredith Adler, an analyst at Lehman Brothers. "They pick up good quality stuff that needs to be bought."

Take Atlanta. The 118 Kroger stores there commanded a 36-percent market share at the end of 2001, compared to 34 percent in 2000. The method: acquiring 14 Harris Teeter stores for around $85 million. Meanwhile, Wal-Mart had 18 stores or 6.5 percent of the $7 billion Atlanta food market. "Kroger in Atlanta is extremely well-positioned," says Giblen. "The stores are very high quality." Atlanta fits Pichler's strategy to acquire market share from smaller competitors and then introduce price cuts and new formats with offerings like gasoline.

"The future of the food industry is executing multiple formats at the same time," says Frank Dell, president of Dell Mart & Co., a management consulting firm. "If Ralphs starts to look like Kroger, the game's over."

To stay regional, Kroger's Western divisions like Ralphs, Fred Meyer, and Smith's mostly keep their own buyers, frustrating some suppliers. "Nobody at Kroger runs Fred Meyer," Adler says. "The guys they acquired are the experts." Lately, Kroger is learning from Fred Meyer's best practices in global sourcing and buying and merchandising prowess. The 350 Ralphs stores in California operate as an independent division and are well-run and profitable, according to analysts.

Another secret weapon is killer private label (see sidebar on page 22), which accounts for 26 percent of Kroger's grocery sales dollars in the Eastern division. The motto "Try it, Like It or Get the National Brand Free" is virtually unchallenged. "No consumers ask for refunds," says Flickinger. Most private label is made in Kroger's intricate network of 41 food processing plants. The company began baking in 1901, and today there are seven bakeries making cakes, cookies, muffins, and the like.

Some 15 dairies and three ice cream plants churn out cottage cheese and yogurt. Other additions include two cheese plants, three meat plants, three beverage plants, and two deli plants. Not that they all get high marks. "The bakery is functional," says Flickinger. "It wouldn't be at the same level as Wegmans." But overall, Kroger buys, packs, and sells some of the best private brands in the U.S., he says. Other analysts call Kroger's private label practices the best in the industry. Also, the company can drive its own margins higher—gross margins averaged 27 percent in 2001, net margins 2 percent—and control quality levels.

"Kroger strikes the right balance between private label and branded," says Terry O'Brien, s.v.p. of sales and customer marketing at Morningstar Foods, which supplies all of Kroger. He praises the retailer as a "high-integrity, fair, and aggressive partner." Critics add, though, that self-manufacturing hinders innovation because it takes lots of capital spending to expand lines. Also, plants with under-used capacity must still be carried on the balance sheet.

Organic growth

Kroger also jumped into organics successfully. It sports its own private label natural/organic foods and vitamin supplements called Naturally Preferred. Products include organic cereal, eggs, and snacks. "It's safe to say that natural and organic foods comprise one of the fastest-growing parts of our business," Kroger spokesman Gary Rhodes has said. "It's grown in the double digits over the last two or three years." They're part of the 2,000-SKU organic store-within-a-store operating in 1,100 Kroger stores as of October. "Wal-Mart and Kmart are pulling off lots of customers who want lower prices," says the University of Minnesota's Kinsey. "You must have something else that you're offering, like organics."

Another strength is bundling pharmacies into the stores. Kroger is the nation's seventh-largest pharmacy operator. In 2001, it operated 1,702 pharmacies inside its stores and filled about 105 million prescriptions, bringing in $4.5 billion in revenue, 15 percent ahead of 2000. "Kroger is better than almost anyone else in nonfoods like health and beauty care," says Giblen.

The company's biggest challenge now is defining its consumer. "Kroger became a national chain by acquiring lots of different banners," says Stern of McMillan Doolittle. "Concepts that are more targeted are taking business away from them." Meanwhile, Wal-Mart is just a price vehicle, adds Merrill Lynch's Husson, "so you have to emphasize quality of service and products." It comes down to execution, a Kroger strength, but analysts would counsel the chain to pay even closer attention to Wal-Mart and its interaction with customers. "Wal-Mart has cracked the code in food merchandising," says Giblen. "Ten years ago they were pathetic."

"Supermarkets must bring costs down," says David Rogers, president of DSR Marketing Systems in Deerfield, Ill. "And manufacturers must change grocers' slotting allowances. It's being crushed out of the system anyway because Wal-Mart won't play those games." Of 35,000 items in a supermarket, grocers take losses on 14,000, one analyst estimates. "And Kroger probably has as many negative profitability items as anyone else," says Dell.

As Wal-Mart continues to expand—recently announcing a plan to increase its total retail space by 8 percent—flexibility in formats becomes ever more important for supermarkets' survival. Kroger formats vary from its discount Food 4 Less stores to convenience stores—nearly two dozen banners. "Overall, Kroger has a lot of tools, like different store formats," says C.L. King's Giblen. "They can be low price or high on service."

Kroger isn't afraid to close weak stores. It exited the El Paso market, where it was trailing Wal-Mart in third place. And geographic diversity adds ballast. "Kroger is like a big portfolio," says Lehman Brothers' Adler. "You get very different competitive markets that smooth each other out. The end result is less volatility in earnings."

The West aside, Kroger is centralizing fast to pare costs. Until recently, divisional managers ruled so powerfully that when the chief executive's spot was available, no one wanted it, according to a source. But that's changing as Kroger slashes $500 million from operating costs to invest in fighting price wars and promotions against Wal-Mart. Centralization of buying, once done divisionally, is key. Kroger has already brought meat, produce, and HBC buying into the Cincinnati headquarters; this year, it's concentrating on dry groceries.

Noting the $500 million, Merrill Lynch's Husson remarks, "That's huge—bigger than the cost savings of acquiring Fred Meyer [$380 million]. Though Kroger's reaction time is rather slow, when they do grind into action, they're pretty decisive."

For example, where 12 divisional buyers reportedly did the dairy purchasing before, the entire job is now handled by one. The advantages are speed and efficiency. "Manufacturers are now freed up to provide more value-added tasks like category analysis," says Morningstar's O'Brien. Now, he says, buyers have bigger sales rates on which to base decisions on self-manufacturing versus outsourcing.

Girding for war

Being prepared to fight price wars is the goal. According to Deutsche Bank, Kroger pricing runs 13 percent to 24 percent higher than pricing at Wal-Mart supercenters, leaving some squeezing room. "Kroger must get its prices closer to Wal-Mart," says Merrill Lynch's Husson. "Last year, Kroger allowed the spread to get too wide. As they've reduced their prices, they're slowly getting more share of stomach."

The chain is employing technology in its assault. At checkout, it was a pioneer in self-scanning. "Kroger is ahead of the game in certain self-service checkout, such as in express lanes and simple transactions," says Stern. And recently it began testing Secure Touch-n-Pay programs, where customers' fingerprints are scanned and then linked to their driver's licenses.

As for the supply chain, Kroger has been revamping it since 1995, closing 24 distribution centers. "Kroger was early in outsourcing distribution," says Giblen. "It has figured out how to get third party distribution cheaper than the unions." Distribution is broken down into three tiers, from fast turning to slow, a very sophisticated system, says Lehman Brothers' Adler. "They're the only big chain to segregate between fast- and slow-turning items." To speed supplies, Kroger is building a $90 million distribution center in Columbus, Ohio, replacing three other facilities. It will ship groceries, produce, and frozen foods to 120 Kroger stores.

Matching Wal-Mart's reams of customer data, compiled and configured in-house, remains daunting to Kroger, though. Wal-Mart gives suppliers almost twice as much information as supermarkets, so they can pinpoint the right assortments in the right place, says one source.

But while Wal-Mart is the 800-pound gorilla, Kroger is the 500-pounder. "Kroger now intends to use its size to stifle the monkeys," says Jonathan Ziegler, an analyst at Deutsche Bank Securities. In a highly fragmented market, that's good enough for now.